The business cycle, as we have previously known it, possibly does not exist anymore. Technically, the business cycle is the alternating periods of expansion and contraction of economic activity, explains Kelley Wright, a leading dividend expert, market strategist and editor of Investment Quality Trends.
Historically, these periods follow a pattern of bottoming out, aka a trough, followed by expansion, then topping out or a peak, followed by a contraction, aka a recession or in severe instances a depression, down to a trough, rinse, and repeat.
The reason I have been thinking the business cycle may not exist anymore is that over history, expansions and contractions were fairly repetitive events. The economy would expand and get too hot, the Fed would step in, raise rates, typically too much for too long, and bada boom, bada bing, the economy would roll over into recession.
Today, the Fed does the exact opposite, which is to ease monetary policy even though the economy is in a rip your- face-off expansion, resulting, for all intents and purposes, in the demise of the business cycle.
This counter shift of monetary policy can be traced back to the extraordinary monetary measures introduced during the 2008-2009 financial collapse and have remained in place since.
Barring the pandemic, it begs the question if the boom that began in 2009 would have gone on uninterrupted, the Buzz Lightyear Boom, to infinity and beyond if you will.
Another question is what impact does the Buzz Lightyear Boom have on stock prices? I mean seriously, if the economy can expand unabated as far as the eye can see, why can’t stock prices go up forever?
Okay, so there have been a few scorching sell offs since ’09, but these were short-lived as the Fed seemingly knew the exact moment to whisper sweet words of reassurance, and as if by magic, crisis averted.
The upshot is there is an entire generation of, how should I say, market participants, who know nothing but an ever-expanding economy and stock prices that always go up. When there was a normally functioning business cycle there was a natural distribution, or selling, of positions when the economy began to overheat.
Investors knew that at some point the Fed would begin to tighten, which naturally would result in companies pulling in their horns by laying off employees and reducing capital expenditures. Inevitably stock prices would decline, yields would increase, and after sufficient value was restored the cycle would begin anew.
Is it possible, I wonder, if an up-cycle can really go on forever? If it can, it will destroy everything ever understood about economics and markets. That, my friends, is a brave new world indeed.
Back in the day it was known that the Fed would tighten until something broke. Perhaps, in this counter-intuitive, counter-cyclical world of today, the Fed does nothing until something breaks. For all those market participants who know nothing but never-ending expansion and valuations without limitations, well, let’s just say it could get real ugly real fast.
The bond market has been content to play along since ’09, basically collecting a paycheck while doing nothing. If, at long last, the bond market is truly awakening from its slumber, the Fed may be content to switch roles and let the bond market lead yields higher, a de facto tightening if you will.
The thing is a normally functioning bond market, historically, isn’t into incrementalism. If they have a yield target in mind they’ll just go there without regard to the consequences. Welcome to the big-league boys and girls.
My suspicion is the yield to watch for on the 10-Year is 2.0%, anything below that is status quo. If 2.0% gets pierced with enthusiasm, however, the next resistance level is 3.25%. Although still low by historical standards, 3.25% is going to cause a disturbance in the "Force" because for the first time in a long time there will be a viable alternative to equities.
To remain competitive the dividend yields on stocks will have to increase, which will be accomplished either by higher cash dividends, lower stock prices, or a combination of the two.
Given the propensity for the stock market to hang on for dear life as long as possible, the day of reckoning, if there is one, is still probably a ways off, perhaps at the end of the year or early into 2022.
In the words of my late grandfather, we’ll know when we get there. No matter what happens in the market today, tomorrow or some point later in the calendar, however, it is more prudent to be aware of the valuations in your portfolio than the valuation, or lack thereof, in the broader market. In short, pay attention to your portfolio and let the market look out for itself.